Goldman Settles Its Battle With SEC

$550 Million Deal Ends Showdown That Shook Street

By

Susanne Craig And

Kara Scannell

Updated July 16, 2010 12:01 a.m. ET

In one of the largest penalties in Wall Street history,
Goldman Sachs Group
Inc.
agreed to pay $550 million to settle civil charges that it duped clients by selling mortgage securities that were secretly designed by a hedge-fund firm to cash in on the housing market's collapse.

But the agreement with the Securities and Exchange Commission ends a showdown that had deeply shaken America's most powerful financial firm at a cost that outside observers deemed a bargain.

Goldman conceded it made "a mistake" by not disclosing the role of Paulson & Co. to investors for a deal dubbed Abacus 2007-AC1. The firm vowed to toughen oversight of mortgage securities, certain marketing materials and employees who create or pitch such securities.

Criminal prosecutors still are looking into whether Goldman or its employees committed securities fraud in connection with its mortgage trading, according to people familiar with the matter. Goldman hasn't commented on the criminal probe.

Yet Goldman walked away with several victories that raise questions about the strength of the SEC's case. The company wasn't forced to sacrifice any top executives, including Chief Executive
Lloyd C. Blankfein
,
as some executives had feared. The changes it agreed to won't weaken its profits or standing as Wall Street's mightiest firm. The record-setting penalty is equivalent to just 14 days of profits at Goldman in the first quarter.

"That is a steal," said
Michael Driscoll,
a visiting professor at Adelphi University and a senior managing director at firm Bear Stearns Cos. before that firm collapsed in 2007. Analysts had expected Goldman to pay at least $1 billion as part of the deal.

The Case Against Goldman

Review the cases of E.F. Hutton, Prudential Securities and other firms that fought SEC charges.

Goldman shares surged late in the day on expectation of a pact, and continued to rally in after-hours trading. The stock was up $6.16, or 4.4% to $145.22 in New York Stock Exchange trading in regular hours, and then another $7.13, or 4.9%, to $152.35 after hours.

The firm's traders, investment bankers and other employees expressed relief that the three-month legal ordeal, which erased nearly $20 billion of the company's stock-market value, was over. Executives believe the $550 million payment is tiny compared with the business Goldman could have lost if the case dragged on. Goldman brass told managers to make sure the reaction inside the firm was subdued, fearing that cheering or other celebration would further taint the firm's reputation.

The settlement must be approved by U.S. District Judge Barbara S. Jones in New York.

The SEC said the Goldman settlement represents the largest penalty it has ever extracted from a Wall Street firm. In 1988, Drexel Burnham Lambert Inc. agreed to pay $650 million in fines and restitution, but about half the total went to satisfy civil claims of investors and clients defrauded by Drexel.

In 2003, meanwhile, a group of 10 Wall Street firms agreed to a $1.4 billion settlement of charges that research analysts improperly touted stocks to help investment bankers win business from corporate clients.

Other banks and securities firms quietly expressed optimism that the SEC's continuing probe of Wall Street's mortgage machine will be resolved without major fines or humiliating revelations about deals done during the mortgage bubble.

In a statement, Goldman said the settlement "is the right outcome for our firm, our shareholders and our clients." The firm also said the SEC completed a review of other collateralized debt obligations created by Goldman. The company said it "does not anticipate recommending any claims against Goldman Sachs or any of its employees with respect to those transactions based on the materials it has reviewed."

The Wall Street Journal reported Wednesday that Goldman wanted to simultaneously resolve the fraud lawsuit and some of the agency's lower-profile probes of the company's mortgage department. Goldman hasn't said which mortgage deals were scrutinized by the SEC. The agency could reopen the examinations if new evidence of wrongdoing surfaces.

Robert Khuzami, the SEC's director of enforcement, said the settlement is a reminder to Wall Street firms that they must deal fairly with clients, "even if the product is complex or the investor sophisticated."

SEC officials said the settlement includes concessions ranging from a substantial penalty to a contrite admission by Goldman, which had never acknowledged wrongdoing in the Abacus deal. The agency is plowing ahead with its investigation of mortgage-related securities sold by Wall Street.

Mr. Khuzami declined to say why the SEC didn't demand management changes. He said the timing of the settlement had no link to Thursday's passage in the Senate of financial overhaul.

The SEC said Goldman agreed to cooperate in the investigation of
Fabrice Tourre,
the Goldman trader accused by the SEC of being "principally responsible" for piecing together the bonds and touting them to investors.

Mr. Tourre faces a Monday deadline to respond to the allegations by the SEC in its April lawsuit or seek an extension. Mr. Tourre, who still works at Goldman but is on paid leave, plans to file a response Monday and continue trying to clear his name, according to a person familiar with the matter.

Settlement discussions between the SEC and Goldman began in early May and gained momentum in recent weeks, say people familiar with the matter. The agreement was sealed in principle on Wednesday, and the SEC's five-person commission approved it Thursday afternoon.

The settlement includes a $535 million civil penalty and the handover of $15 million in profits Goldman made on the Abacus deal. Goldman will pay $250 million to investors in the Abacus deal, including $150 million to IKB Deutsche Industriebank AG, a German bank that invested the same amount in a slice of the mortgage securities. The U.S. government gets the remaining $300 million.

Paulson & Co., the hedge-fund run by
John Paulson
that helped design the Abacus deal, wasn't accused of wrongdoing. A spokesman for the firm declined to comment Thursday.

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